XIN WANG, PHD CANDIDATE, LEICESTER LAW SCHOOL, UNIVERSITY OF LEICESTER.

9 July 2023

Cite: Xin Wang, Bank Insolvency and Resolution Regime in China, Global South Network Blogs, 9July 2023. https://globalsouthnetwork.com/bank-insolvency-and-resolution-regime-in-china/

The gaps between the law and its practice creates various problems in bank insolvency cases that could undermine a country’s economy. This blog aims to highlight those problems and propose potential solutions to that. It has four parts. The first part introduces the background and the legal framework of bank resolution and insolvency in China. The second part introduces some gaps between the law and reality, which will describe what happens in real bank insolvency cases. The third part is a conclusion of key problems of the current approach. The final part is some solutions to the problems.

The Background and the Legal Framework of China’s Bank Insolvency Regime

Bank insolvency in China is a novel regime and the development of the bank insolvency regime has some unique features. Initially, before the 1990s, China’s banks could not go insolvent because China was a strict socialist country and banks were regarded as government agencies during that time. Then, with a shift from strict socialism to a new market-socialism model, China’s banks have been gradually commercialised as individual and independent institutions. They are allowed to go insolvent. But the connection with the state is still strong, which leads to a situation where the survival of banks has virtually been guaranteed by the government and it is rare to see the insolvency cases of banks.

At present, there is no specific statute for bank resolution and insolvency in China. So the relevant articles are stipulated in the Law on Commercial Banks 2015, the Law of Regulation and Supervision over the Banking Industry 2006, the Enterprise Bankruptcy Law 2006, and the Deposit Insurance Regulation 2015. The administrative resolution regime, such as the takeover and restructuring process, is regulated in the first two statutes, the Law on Commercial Banks 2015 and the Law of Regulation and Supervision over the Banking Industry 2006. The general insolvency law, the Enterprise Bankruptcy Law 2006, stipulates the grounds for bank insolvency and insolvency procedures, such as court-based administration and liquidation procedures. The Deposit Insurance Regulation 2015 stipulates the depositor compensation scheme, the use of the deposit fund and some responsibilities of the deposit institution.

Generally speaking, if the banking regulators find that a bank does not fulfil the regulatory requirements, such as the balance sheet and cash flow test or capital adequacy ratio, the regulators may take early measures to take over the bank’s management or order the struggling bank to restructure.[i] Usually, taking over the bank’s management means that the bank faced a serious problem, and it will largely go insolvent. However, it is still unknown whether the takeover process is a necessary condition for the insolvency proceeding under the current legal framework.

According to the Enterprise Bankruptcy Law 2006, if a commercial bank fails to pay its debts, the financial regulatory authority may apply to courts for administration or liquidation[ii]. The court should obtain the permission of the banking regulatory authority before issuing the insolvency order.[iii] A moratorium will be issued by courts when the bank is under either an administrative takeover by regulators or court-based insolvency proceedings.[iv] In addition, the Enterprise Bankruptcy Law 2006 stipulates that the failed bank and its creditors could file for insolvency.[v] The deposit compensation process will initiate at the moment of the acceptance of the insolvency petition by the courts.[vi] According to the Deposit Insurance Regulation 2015, all eligible depositors, including deposits in Chinese and foreign currencies, could receive up to RMB500,000 within seven working days.[vii] The exceeding part of the deposit would be paid during the liquidation process.[viii]  After compensating depositors, the deposit insurance institution obtains the right of subrogation in the same order as subrogated depositors in the liquidation procedure.[ix]

Gaps Between the Law and Reality

With the bank insolvency cases emerging in 2019, the current legal framework has faced the test. The authorities found that the existing rules are too ambiguous to deal with bank insolvency cases, so they exercised their discretion to execute bank resolution and insolvency process. Therefore, it formed a new version of the regulator-managed bank resolution and insolvency regime. So the contrast between the new ad hoc regime and the more predictable rule-oriented mechanism has become a big concern at the moment.

Take Baoshang Bank as an example. On May 24, 2019, Baoshang Bank was taken over by the People’s Bank of China (the central bank) and the Banking Regulatory Commission due to the serious risk. The takeover team first took over the management of this Bank, and then, it authorised a big state-owned bank, China Construction Bank, to manage the businesses of this bank. During the takeover period, the takeover team used the deposit insurance fund to pay all individual saving depositors and up to RMB 500,000,000 (100 times more than the prescribed amount) to non-individuals to maintain social stability.[x] It is worth mentioning that the authorities did not follow Article 5 of the Deposit Insurance Regulation 2015 to pay off depositors. This is the first point where practice differs from the law.

The second gap between the law and reality is about the commencement of the depositor compensation process. In practice, the depositor compensation process commenced during the takeover time, which is different from the law. The Deposit Insurance Regulation 2015 stipulates that the commencement time of the depositor compensation scheme is when (1) the deposit insurance institution is one of the members of the takeover team, or (2) the deposit insurance acts as a liquidator, or (3) the court accepts the failed bank’s insolvency petition. Actually, the practice in the Baoshang case did not comply with this rule. In this case, the deposit insurance institution neither was one of the members of the takeover team nor the liquidator; and the compensation was initiated far earlier than the moment when the court accepted the failed bank’s insolvency petition. Arguably, it seems that the practice for this point is more reasonable than the law.

The third gap between the law and reality is the creditor claim issue. In theory, during the takeover process, only eligible depositors would be paid by the depositor compensation scheme or have their accounts transferred to another bank. But the authorities also paid other creditors through the deposit insurance fund in the Baoshang bank insolvency case. According to a newspaper report, interbank liabilities are also paid by the deposit insurance fund. These measures completely abandoned the liquidation rules in the Enterprise Bankruptcy Law 2006. Thus, the court-based bank insolvency procedure, especially the liquidation process, becomes merely a formality. Under such circumstances, the creditors who have not been paid during the takeover time will bear all losses departure from the pari passu principle in the general insolvency law.

The last point of the gap between law and reality is the usage of deposit insurance funds for bank resolution. The law stipulates that the deposit insurance institution could provide the guarantee, share losses, or give financial support for insolvent banks, but it must follow the least cost principle. Given that the legal framework is too ambiguous, there is no specific standard for the usage of the deposit insurance fund. The implementation completely depends on the regulators’ decision. The most controversial issue is whether the deposit insurance fund could be spent on the bank’s acquisition or the new bank’s establishment. For instance, when some assets and debts of Baoshang Bank were separated into Mengshang Bank and Huishang Bank. Actually, these two banks can’t afford the debts. To solve this problem, the regulator used RMB15.49 billion of the deposit insurance fund to capitalise on Mengshang Bank and Huishang Bank.[xi] Notably, there is no ‘bridge bank’ mechanism in China. The deposit insurance corporation has not announced that it will sell the shares of these two banks and return the fund to the deposit insurance pool in the future. Thus, some argue that the deposit insurance fund may be abused in China.

The Key Problems of the China’s Approach

Firstly, many existing provisions are too general or ambiguous, which gives too much leeway to the Chinese authorities in handling bank failures and sometimes the authorities probably abuse their powers.

Secondly, there is no reasonable depositor guarantee scheme. There are only twenty-three provisions in the Deposit Insurance Regulation 2015, in which most provisions are descriptive while some are controversial and unclear.

The third point is about the conservative idea of the government. For politicians, maintaining social stability is more important than addressing the failed banks in a lawful and sustainable way. For example, the government may request a healthy state-owned bank to acquire some troubled banks for the sake of maintaining financial stability, and the government does not willing to allow a failed bank to enter the insolvency proceeding directly. This is also the main reason for the insolvency of Hainan Development Bank in 1999. After merging 28 small banks that had already been in a payment crisis, Hainan Development Bank not only failed to save these small banks but also found itself in a payment crisis. Then, Hannan Development Bank went insolvent.

Finally, there is always a strong backup by the state and banks seem to be easily bailed out by the government. Given that the prevailing attitude of the authorities is to keep banks surviving and the government is used to subsidising failing banks by either recapitalising or offering state finical aid, the commencement of bank insolvencies in China becomes very difficult.

Solutions and Policy Recommendations

To solve the issues mentioned in the last part, it is necessary to vary the current general insolvency rules to adopt the bank insolvency case. Moreover, to deal with the structural problem, a consistent bank resolution model should be set up, from the pre-insolvency rescue process to the insolvency proceeding. Due to the characteristic of the Chinese approach, it is reasonable to allow banking regulators to play a central role in the process of bank insolvency, but it is also reasonable to tie the regulators’ powers in the meantime. In addition, the legacy problem needs to be eliminated, including legislative and conventional ones. In other words, it is necessary to improve the trigger standard of bank insolvency, change the old attitude about the unwillingness of entering bankruptcy procedures, and revise the implicit state guarantee for all depositors.

In conclusion, the current legal framework of bank insolvencies relies on the normal insolvency law, but the normal insolvency law cannot adequately solve the issues of banks. Many provisions are too general or ambiguous and it is hard for the regulators to address the bank insolvency cases. The aim of bank resolution and insolvency is to impose losses on investors in failed banks while ensuring the critical operations of the bank by providing some resolution powers. Shareholders and creditors profit when a bank is healthy, and they should therefore take the hit when a bank gets into trouble. This relationship between risk and reward strengthens incentives for banks to demonstrate to their investors that they are not taking excessive risks. It also reduces the unfair competitive advantage of large banks that investors consider ‘too big to fail’ and creates the conditions for a banking sector in which both entry and exit are easier.

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[i] Law on the People’s Bank of China 2003, Article 38.

[ii] Enterprise Bankruptcy Law 2006, Article 134.

[iii] Ibid

[iv] Law on the People’s Bank of China 2003, Article 71.

[v] Enterprise Bankruptcy Law 2006, Article 7.

[vi] Deposit Insurance Regulation 2015, Article 19.

[vii] Ibid, Article 5 and 19.

[viii] Ibid, Article 5.

[ix] Ibid.

[x] Yu Wu, ‘Taking over the Management of Baoshang Bank is Just an Individual Case and the Current Financial System is Safe and Well-Controlled—Response Inquiries by PBOC’ (Baoshang Yinhang Beijieguan Shi Gean, Dangqian Jinrong Fengxian Zongti Kekong)’ (Xinhua News, 2 Jun 2019) <http://www.xinhuanet.com/fortune/2019-06/02/c_1124574561.htm > accessed 11 May 2023.

[xi] Jie Cheng, ‘China’s Deposit Insurance Protects more than 99% of Depositors (Zhongguo Cunkuan Baoxian Quane Baozhang 99% Yishang Cunkuanren)’ Beijing Youth Daily (Beijing, 16 March 2020) < https://www.jnnews.tv/p/961195.html&gt; accessed 11 May 2023.

Xin Wang is a PhD candidate and a teaching assistant at the Law School of the University of Leicester. Her main research area is finance and commercial law. Her PhD thesis is about the bank insolvency issue. Her article, ‘The Commencement of Bank Insolvencies in China: Problems and Prospects’, was published in Tsinghua China Law Review in 2022, which is the top English-based law journal in China. She has been a teaching assistant at the Law School for two years and she teaches undergraduate contract law. She obtained her LLB and LLM from the Southwest University of Political Science and Law in China, in addition to a further LLM degree (international banking and finance law) from the University of Leeds in the UK.